Christian Osgood explains option contracts for buying multifamily properties when traditional financing won't work. You pay a fee for the right to buy at a fixed price within a set term, and can use structures like lease-options or management-options to improve the property before securing debt. A case study shows how an option contract resolved a flooded hotel conversion by letting an investor lock in a three-year purchase right on a separate building.
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If you are a real estate investor or aspiring real estate investor, the option contract is something you need to understand. Now, the goal of real estate is to own it, put the property in your name, title, and the debt, own the real estate. However, the option contract offers us a lot of flexibility. You need to understand how to use these if you're doing creative finance or otherwise building your portfolio. Welcome back to the channel. My name is Christian Osgood and I'm going to be your host of today's episode. We're talking about the option contracts. Now we've used these creatively in our portfolio, but I think we need to break down first what is the option. If you haven't yet, like, subscribe, follow, hit all those buttons. It really helps us grow the channel. And we're off to the races. The option contract, all it is, is typically for consideration, so some monetary amount, you have an option to purchase a property at a fixed price at a fixed period of time. For example, a million dollars for a 10-unit apartment building. For some reason It doesn't make sense to buy right now. Maybe the financing is not lining up. Maybe we need to wait for the future. Maybe it's not the right time for the seller. They have a tax reason why they want to sell in a future year. Whatever the reason is, it's not time to sell. But you want to lock down this asset. In this example, say it's 10 units for $1 million. We could put $50,000 down that applies towards the purchase as an option fee, nonrefundable, but will apply if you close on the property. Now, at any point in the next— we'll say it's a 3-year option— any point in the next 3 years, we can execute this contract. We have the exclusive right to purchase. In addition, because I have that control over the purchase of the asset, you can sell your option to another individual unless there's a specific clause that prohibits you from doing so. So it's a way to get control of the acquisition of a property, put a pin in the map for, hey, we are going to buy it in this timeline, if there's some reason that is not the right timing for you. Now, option contracts are interesting. Now, a A lot of times you can get direct control of the property. Here's a good use for an option. Say that it's not conventionally financeable because it's been mismanaged, rents need to be brought up, maintenance needs to be done. There's something not bankable about the property. However, the owner has debt and is not willing or able to clear all that debt. So seller financing the asset is off the table unless you buy it in cash, which may or may not work. If you can't just buy that thing in cash or with hard money, The option is, okay, what if I got control of the asset? What if I increased the rents, got it to where it needs to be, had a reasonable time to do so, and then purchased the asset at a fixed price that we've negotiated? It's a fantastic way to do this. I run into a lot of properties where the owners have more or less run the property into the ground, sometimes to a point where the bank won't look at it. Now, if they have, you know, low debt on the property, then we can go ahead and clear the debt with a down payment and we can go ahead and have them either seller finance, do a land contract. There's a lot of ways where we can own the property today that I definitely prefer. However, if you have an amazing opportunity, you love the asset, you love the price, you understand the project, but there's a reason that you can't buy it with either hard money or bank debt, the option contract on a lease option may be the way to do it. You're essentially leasing the entire building and subletting it out to the tenants. You gain control of the building and you have the exclusive right to purchase. Now, in some states, such as Washington, you actually can't sublease commercial multifamily. In this case, we use the management option contract where part of the consideration is the management agreement of the property. So instead of subleasing it, you come in as the manager with an option to purchase. It's a little caveat, but you can get right around the same thing with effectively the same structure. Looks very slightly different, but you tie it to a management contract as opposed to a master lease. Either way, the management option, the lease option, these are ways to get direct control of a property and make that property better so you can move it into the debt product that you want in the future. Now, the other reason you would do this, options can give you, again, pins in the map. A little— you put out your timeline and go, okay, I'm buying this, I'm buying this 24-unit over here and an 8-plex over here and 100-unit thing right here. It's not the right timing for me, but I do want to buy time.. It doesn't need to be a lease option. It doesn't need to be a, it doesn't need to be a management option. What you can do is actually just put together an option fee and say, hey, I would like to do this. Here's nonrefundable money in exchange for tying up the property. If the seller is not in a rush to sell, it's a property you know you want and it's worth the money to lock that up. You can do these option contracts and have the exclusive right to the property. If you change your mind down the line, Most options are sellable. You have an exclusive contracted right to purchase this property. If you opt not to, you can still make money by selling that option to another party. If you are doing an option contract specifically to get time on the property— so this isn't the control play, this is, it's not the right timing for me to onboard this right now, so I'm going to go ahead and purchase an option— if that is your reasoning, make sure that you have the out of being able to sell it. You can absolutely have sellers put a clause in there that says this option is only executable or non-transferable. So make sure that you create a transferable option and you can lock up properties. These are the main uses that are acceptable for options. The wrong use for an option contract, because way too many people do this: I just want the revenue, I want to arbitrage stuff, I'm going to lock this up, I'm going to try to cash flow it for a short period of time. It gives me flexibility. If you are an investor, buy real estate. If you want to be a real estate investor, don't just go for the margin. You want appreciation beyond just, hey, this is a way for me to lock up some cash flow and maybe sell the option later. There are a lot better ways to execute a deal. So option contract in a nutshell, you're purchasing an option, an exclusive right, typically a transferable right to buy a property. Before you go and execute these, make sure that the deal is not one, 1, seller financeable. 2, available on pretty much any other way you could buy the deal. Does it work with a hard money or private capital raise where we can just go ahead and just buy it in cash right now? The goal is always to own. If that is not an option, you don't need to give up. Look at option contracts. How do you execute them, put in your portfolio? Practical example of where we've actually used an option contract. This was the management option. We had a partnership that had 2 separate buildings. One was a multifamily building that they bought into. The other one was a hotel conversion, converting a 23-unit hotel into multifamily that we were working on as an active project. Partway through, the entire building flooded and there was an exemption in insurance where we could not get our insurance claim done. So we had basically total loss of building. The other partner could afford to do the project. We were already doing other projects. We could not take on an additional project. How do we get out of this profitably? We traded pieces in exchange for him getting an option to buy the commercial multifamily building, the original building. He got an option contract. We then seller-financed the other building, the one that had all the problems that needed a lot of money. We seller-financed that to him for just under $200,000. So really what happened is we were risking total loss of building. Instead, we got paid on a seller-financed note, we went ahead and option contracted our equity. He gave us back all the equity to back that note. So now we have a very secure position over here. He has an option to purchase within the next 3 years at a fixed price this asset, and he can use his money to fix up the hotel. That was the immediate issue. It was a way to put a pin in the map on this transaction so he could fix the other problem first. That is a great use of an option contract. It takes a little bit of creativity, but if you understand these, it's a way to buy time or delay a transaction to better move your pieces. I hope this video is helpful. If you want to learn more about creative finance options, seller financing, running your business, or multifamily in general, like, follow, and subscribe to this channel, Multifamily Strategy. We appreciate you. We'll see you on the next episode.
